State ERS reports
$600M growthThe retirement fund ends 2003
with a gain of 21.8 percent
There's nothing like a healthy economy to bring an ailing pension fund back to life.
The state Employees' Retirement System, escaping the shadow of a 3-year-old bear market, posted an 8.9 percent investment return in the second quarter ending Dec. 31 to put itself in position to achieve its best fiscal year gain since the height of the bull market.
Six months into fiscal 2004, the state's largest pension fund is up 12 percent and on pace to eclipse its double-digit returns of 18.8 percent in 1997 and 16 percent in 1998. The fund ended the 2003 calendar year with a gain of 21.8 percent.
"The fourth quarter was a rousing end to an outstanding calendar year," said Ronald Peyton, president and chief executive officer of Callan Associates Inc., the San Francisco-based firm that helps ERS manage its investments.
The fund's asset value also grew about $600 million from the three-month period ending Sept. 30, and stood at $8.5 billion on Dec. 31. The investment gain actually accounted for an asset increase of $700 million to $750 million since about $100 million to $150 million was drawn down for benefit payments. The fund's highest asset level ever was $9.9 billion on June 30, 2000.
"If you told us a year ago that we'd be sitting with these kinds of results, I don't know that anyone would have believed you," Callan Vice President Matthew Beck told the ERS board yesterday during a quarterly performance review. "We've very pleased with the absolute results and determined to work out some of the performance issues of the individual managers" on the watch list.
The ERS, which provides retirement, disability and survivor benefits for 97,000 city, county and state retirees and their beneficiaries, rode the coattails of a strong overall stock market last quarter.
The Dow Jones industrial average climbed 13.4 percent during the final three months of the year. The Nasdaq composite index jumped 12.3 percent, and the Standard & Poor's 500 index gained 12.2 percent. ERS's quarterly gain brought its 10-year annualized return to the 8 percent level that it targets in its policy.
"I think that's significant compared to where we were, say, four quarters ago," Beck said.
The ERS fund, which invests in stocks, fixed income, real estate and alternative investments such as timber, ranked in the 35th percentile (the lower the number, the better) in the quarter among 46 large public funds. Its 8.9 percent gain exceeded the 8.6 percent median for large public funds but fell short of ERS's composite benchmark return of 9.7 percent.
It was a comeback performance for domestic equity, which makes up the largest portion of ERS's portfolio at 46.1 percent ($3.9 billion). ERS's domestic equity funds gained 12.7 percent last quarter compared with the large public fund median return of 12.3 percent.
"At this time last year, I recall thinking that we were well positioned, if the markets did move, to take advantage of them," Peyton said. "I believe there were questions raised about the strategy a year ago by certain parties. Not only has the strategy worked, but the managers have worked very well. One of the biggest problems we've had here for many years is getting the domestic equity managers performing. There have been a lot of terminations of domestic equity managers, and (the replacements') records have improved substantially. That's really encouraging."
International equity, representing 17.3 percent of the portfolio, had a 15.7 percent gain, but trailed the large public fund median return of 16.2 percent.
On the fixed income side, domestic fixed income (19.3 percent of the portfolio) lost 0.5 percent compared with a 0.4 percent median gain by large public funds. International fixed income (7.1 percent of the portfolio) gained 6.1 percent, slightly worse than the large public fund median of 6.6 percent.
Of the two remaining asset classes, real estate (7.1 percent of the portfolio) gained 1.8 percent while alternative investments (3.2 percent of the portfolio) increased 5.8 percent.
The ERS also decided yesterday to drop one fund manager and keep four others, including Bank of Hawaii, on its watch list due to recent underperformance.
The latest fund manager casualty is Schroders Investment Management, an international equity fund that accounts for 5 percent of ERS's total portfolio and has been on the watch list since May 12. The ERS board decided to transfer Schroders' assets, worth $428.7 million as of Dec. 31, to State Street EAFE index, which at year-end had $155.6 million, or 1.8 percent, of the ERS portfolio. The board approved the move because Schroders is closing on March 31 the fund it manages for ERS due to the departure of lead portfolio manager Deborah Chaplin and the retirement of second-in-command Sheridan Reilly.
Earlier this fiscal year, the ERS board fired Putnam Investments because it permitted after-hours mutual fund trading, and dropped AllianceBernstein for poor performance. ERS is now in the contracting process for replacement funds.
Meanwhile, Bank of Hawaii, which has been on the watch list since Nov. 12, 2002 -- the longest of any of the other current watch list managers -- finished last quarter with its large-cap growth fund gaining 9.5 percent, putting it in the 61st percentile. It was initially put on the watch list due to underperformance in 2001 and 2002. The fund subsequently had organizational issues, including the departure of several key professionals as well as a newly announced research partnership with Chicago Equity Partners.
Beck noted, though, that Bank of Hawaii's performance improved over the 2003 calendar year and finished in the 36th percentile with a 28.3 percent return. He said that Callan will do "a couple more visits to them" and that if Callan sees continued performance, it would recommend watch list removal.
Other managers on the watch list are Capital International (emerging markets, 15 percent gain in the fourth quarter, 92nd percentile), Bank of Ireland (international equity, 16.4 percent, 36th percentile) and Bradford & Marzec (domestic fixed income, 0.9 percent, 53rd percentile).
Among ERS's top performers, Bishop Street, which is in the same large-cap growth category as Bank of Hawaii, posted an 11.2 percent return last quarter to rank in the 16th percentile. For the calendar year, Bishop Street, whose parent company is a wholly owned subsidiary of First Hawaiian Bank, was up 27.6 percent to rank in the 46th percentile.
Hawaii-based CM Bidwell, which runs a large-cap core equity fund, ended last quarter in the first percentile with a 14.3 percent gain and was in the first percentile for calendar year 2003 with a 33.8 percent increase.